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A stock pays an annual dividend of $8.4 in one year time. The dividend is expected...

A stock pays an annual dividend of $8.4 in one year time. The dividend is expected to increase by 7% per year (roughly the inflation rate) forever. The price of the stock is $73 per share. At what cost of capital is this stock priced?

Select one:

a. The cost of capital is 18.51%

b. The cost of capital is 19.51%

c. The cost of capital is 17.51%

d. The cost of capital is 19.01%

Solutions

Expert Solution

Correct option d. The cost of capital is 19.01%

In oder to calculate cost of capital we will be using dividend discount model

The dividend discount model (DDM) is a system for evaluating a stock by using predicted dividends and discounting them back to present value

​D=the estimated value of next year’s dividend

r=the company’s cost of capital equity

g=the constant growth rate for dividends, in perpetuity​

Annul dividend is $8.4; the dividend is expected to increase by 7%

Estimated value of next year dividend = 8.4(1+ 7%)

                                                                        = 8.4 * 1.07

                                                                        = 8.99

We are given price per share of $73

73 = 8.99 / (r – 0.07)

73 * (r – 0.07) = 8.99

(r – 0.07) = 8.99/73

(r – 0.07) = 0.12

r = 0.12 + 0.07

r = 0.19

The cost of capital is 19.01%

jeff jeffy answered 5 months ago
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